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The names Russell Martin and Josh Donaldson invoke memories of some fantastic seasons for many Toronto Blue Jays fans. For tax professionals, they are now also important players in a crucial court judgment released this month.

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The ruling by the Tax Court of Canada involves a form of pension plan called a Retirement Compensation Arrangement (RCA). These arrangements are commonly used by those temporarily working in Canada, who may not be eligible for other retirement plans or who may be subject to contribution restrictions on other Canadian plans. While an RCA can apply to many kinds of employees, it is commonly used for athletes who are non-residents of Canada playing for Canadian teams, often for a short time.

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A third-party actuary determines the maximum amount the employee can contribute to such a plan. Usually, the contributions are subject to a higher maximum amount than, say, an RRSP, but would then reduce the salary distributed to the employee. So, if an employee’s salary is $200,000 and $10,000 is hypothetically contributed to the RCA, they would only receive $190,000. The $10,000 is also subject to an immediate 50 per cent refundable tax from the Canadian Revenue Agency (CRA), and the remaining $5,000 is put into a trust that someone else holds and invests. Any income earned from the investments is also subject to this 50 per cent tax.

When there is a distribution from the plan, presumably when the employee has retired and is in a lower tax bracket, the employee receives back the 50 per cent refundable tax that was remitted to the CRA, and then pays a flat tax of 25 per cent in Canada on the whole distribution if they are a non-resident of Canada.

This is where the tax court case involving the two former Blue Jay players becomes important.

A non-resident athlete playing for a Canadian team is taxed on a proportion of their earnings determined by the days they physically play in Canada. With hockey, for example, that would mean the days they are physically in Canada playing for their home team and against other Canadian teams. For baseball, since there is only one Canadian team, the tax is only applied to the days the players are in Canada. The CRA agreed with the players that 40 per cent of the time, they were physically in Canada, earning Canadian source income, and 60 per cent of the time, they were not in Canada, earning foreign source income. As non-residents of Canada for tax purposes, they would pay Canadian tax on the 40 per cent, again a percentage agreed to by the CRA. The years in question were 2015, 2016 and 2017 for Martin and 2016 and 2017 for Donaldson. Since the same issue was involved, the cases were heard and decided together.

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In 2017, to use one of the common years, Martin’s total salary was US$20,000,000 and Donaldson’s was US$17,000,000, and US$2,451,597 and US$1,815,768 were placed in their respective RCAs.

In Martin’s case, the CRA took the US$20,000,000 less the US$2,451,597 RCA deduction, and then split the taxable remainder of US$17,548,403 between the agreed-upon resident and non-resident days. In other words, he was expected to pay tax on $17,548,403 x 40 per cent, or $7,019,361. The same formula applied to Donaldson. 

The players’ lawyers, however, argued that the 40/60 split should be applied first, and the amount going to the RCA should reduce the Canadian portion of income to be taxed. Martin would thus take the 40 per cent of US$20,000,000 attributable to his days in Canada, or US$8,000,000, and then reduce it by the RCA contribution of US$2,451,597, making his taxable income for the year US$5,548,403.

The players’ approach leads to a significant difference in the deferred income to be taxed, even though the pay and contribution to the RCA are the same in both examples. In the case of the players, the difference in tax bills would be well into the hundreds of thousands of dollars each year.

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In a 60-page ruling, the court said the case hinged on how we read the tax law. All the facts were agreed upon, and no one testified at the hearing. Ultimately, the court sided with the players, determining that the RCA deduction is in the tax code and is a Canadian payment that should be a deduction to income from Canadian sources, not the overall salary.

The ruling has solidified the interpretation many tax professionals previously held about how these plans should work. It will also help to avoid discouraging athletes from wanting to play in Canada.

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